Saving For Your Second Deposit

This is a continuation of our article on saving for your first deposit, which can be found here.‍

So it's been a little while since you settled on your property and you've decided you want to buy another - good for you! There are few things to consider before even thinking about how you're going to fund this purchase.

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Firstly, some financial and personal planning

Start by reconsidering your overall goals, your risk profile and your personal situation. Any or all of these could have changed since your first purchase and adjustments may be necessary. As always, speak to a member of your professional team before making any significant financial decision. You will need to assess any implications that your new purchasing plan may have on your current situation from a financial and tax perspective.

Next, weigh up the personal impact. Whilst growing a property portfolio is a rewarding experience and a fantastic achievement, it does come with its fair share of work. In some respects, the more you own the harder it gets. You can expect to be contacted more by your property manager(s), deal with more maintenance, have increased costs (although these are obviously offset with more rental income), receive more correspondence from your lender, and be required to dedicate more time to your record keeping and accounting.

Funding the purchase

If all of the above has been considered and you are ready to move forward, then the next consideration is how to fund the purchase. This will involve contacting your mortgage broker or lender. Importantly, using one lender for your first property doesn't mean that the second loan should necessarily be with the same lender. All lenders have different products, and as with any market their suitability with respect to price and flexibility varies. Even if you haven't considered one before, using an experienced mortgage broker can help you navigate the marketplace to find a product that suits you at a particular point in time for your growing portfolio.

Now for the savings bit. Remember, you are going to need money for not only your deposit, but additional costs as well. This will come from one of two places, or a combination of both:

1. Cash savings
2. Equity

Cash savings

If your income exceeds your expenditure - which should always be your goal - then (in theory) you should have some money saved. Whether or not you use this for your second purchase is dependent on the amount required vs. the amount saved and how much cash buffer you will have. To work this out, consider a few things:

Firstly, if you are drawing funds from an offset account, it will effectively increase the loan amount that the cash is currently offsetting and therefore increase your interest (and possibly principal) payments on that loan. These increased payments should form part of your overall cash flow calculations.

Secondly, and very importantly, you should consider where the money is coming from in relation to tax. Do not make the common mistake of thinking that you have 'saved money' in a loan redraw account if you are using it from an investment property to fund a principal place of residence. There are significant tax implications on this and we will discuss those soon.

Thirdly, you are going to want to have residual cash reserves after settlement to allow for unforeseen expenditure - both personal and for your newly acquired property.

In a nutshell, it is not wise to use up ALL of your savings to fund the deposit.

‍Equity

If you do not have enough money saved to fund your next deposit and have a comfortable balance afterwards, you can consider the use of equity. Using equity can essentially be done one of two ways - cross securing the properties (also known as cross collateralisation), or using the equity to create a separate loan.

Cross-securing is favoured by the banks as basically involves pooling all of your debt and/or security into the one place, thereby giving them the most control over the cross-secured assets. This is a disadvantage for the borrower because if you default on the mortgage for one property, the bank immediately has access to both properties to find a solution. It's also a disadvantage because if one property goes down in value and the other goes up (assuming the same amount), the bank sees the net value as zero and there is no further equity to use for any additional purchase(s).

The benefits of cross-securing include no mortgage insurance if you plan to go above an 80% loan value ratio (you can use whatever percentage of equity you like), ease of application (the banks make it easier) and often only one mortgage payment.

In general, the preferred method is to draw equity for investment purposes is to create a separate loan facility. This gives you the greatest control and protection over your assets, provides more flexibility with regard to loan changes, and allows easier access to equity as it is based on an individual property's performance. It also allows you to diversify lenders which can be an advantage if you are looking to grow a portfolio and will more than likely require multiple lenders at some point anyway. The downside is more paperwork (both intially and ongoing) and administration to manage the different loans.

As an example, let's consider someone requiring $160,000 (including costs) to purchase a new property:

1. Property 1: Value - $1,200,000, Loan amount - $800,000
2. At 80% LVR, property 1 could increase the loan amount to $960,000 (80% of $1,200,000)
3. Seeing as the loan is currently only $800,000, this means there is $160,000 of available equity
4. A separate loan facility is created for $160,000 that is now accessible when the time comes to fund Property 2

Some important things to note about using equity

Risk

Firstly, the overall debt is increasing and therefore your risk is increasing. Even though you are using equity, you are still borrowing an additional $160,000 against Property 1, meaning that when you use that money you will be paying interest on the $160,000 loan facility and the new mortgage of Property 2. What it does is simply create 100% debt for Property 2, it is just spread over two separate loans.

Tax implications

Secondly, you must be very careful of the tax implications when drawing equity from anything. The rules are very clear with respect to this and state that it is not what secures the property that determines its tax deductibility, it is the purpose of the loan.

For example, if in the example above Property 1 was an investment property and the buyer drew down $160,000 to purchase a home to live in (which is a non-deductible asset), the $160,000 equity loan would no longer be tax deductible, even though it was secured against a deductible asset.

This is particularly important to those people who choose to 'rentvest' with a plan to buy a home in later years. Although you may have significant equity in your current property portfolio to fund a deposit, using it to purchase a home will change your overall tax and cash flow position and therefore is something that should be planned carefully. Often it may be better to liquidate an asset, restructure your portfolio, and then buy back in for maximum tax efficiency. Yes, there will be buying and selling costs but these must be considered as part of your time horizon and long term goals.

This also applies to those who decide to turn their home into an investment property as they upgrade by buying elsewhere. This often results in having a small deductible debt and a large non-deductible debt in the process - the complete wrong way around.

As always, please do not take the above as financial advice. You should consult your finance and tax professional before making any decisions regarding your personal situation, as one big overriding factor with respect to tax implications is that once you've done it, it's very hard, if not impossible to undo. It is usually more affordable to pay for the right advice upfront than try to fix mistakes later.

Please get in touch if you'd like to discuss any of the above or require referrals to tried and tested industry professionals who can help you structure your property purchase the right way.